Does Competition Reduce the Risk of Bank Failure? Articles uri icon

publication date

  • October 2010

start page

  • 3638

end page

  • 3664

issue

  • 10

volume

  • 23

International Standard Serial Number (ISSN)

  • 0893-9454

Electronic International Standard Serial Number (EISSN)

  • 1465-7368

abstract

  • A large theoretical literature shows that competition reduces banks' franchise values and induces them to take more risk. Recent research contradicts this result: When banks
    charge lower rates, their borrowers have an incentive to choose safer
    investments, so they will in turn be safer.
    However, this argument does not take into account the fact that lower
    rates also
    reduce the banks' revenues from performing loans.
    This paper shows that when this effect is taken into account, a U-shaped
    relationship between competition and the risk of
    bank failure generally obtains.